A Wary Look At Mortgage Rates

A funny thing happen to mortgage interest rates in the first three weeks of May: they rose.

If you’ve come to regard 30-year fixed rates of around 3.5 percent as the new normal, you may be in for a shock. Not only are they a historical anomaly, but they are not equipped to stand up to the normal market forces that determine interest rates.

In other words, be prepared for mortgage rates to rise at some point. If the movement in recent weeks becomes a trend, the market may already have reached that point.

Recent interest rate moves

According to mortgage finance company Freddie Mac, 30-year fixed mortgage rates rose by 24 basis points in just three weeks, reaching 3.59 percent as of May 23.

This is not necessarily the beginning of the end for low mortgage rates. Earlier this year rates made another surge before slipping back down close to their all-time lows. However, coming as it does in the midst of generally improving economic news, this latest turn upward in mortgage rates looks like it might have some legs.

A break from inflation – for now

On the positive front, mortgage rates and consumers in general are getting a major break from inflation.

On May 16, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) declined by 0.4 percent in April. On the heels of a 0.2 percent decline in March, this means the CPI has pretty much eliminating its surprisingly large February increase of 0.7 percent. In fact, there has been a negligible amount of inflation over the past 6 months, and the increase for the past 12 months is a very mild 1.1 percent.

The more inflation stays under control, the more confident mortgage lenders will feel making loans at low interest rates. One caution though – the drop in CPI for April was largely due to falling energy prices. In contrast, figures from the US Energy Information Administration show that oil prices rose through the first three weeks of May, so don’t expect the CPI to continue to fall so rapidly.

Asking a lot from 3.5 percent

Inflation is just one of the risks mortgage lenders have to cover with the interest rates they charge on loans. They also have to cover default risk – the risk that a certain portion of borrowers won’t repay their loans, and that the value of their properties won’t be enough to cover the resulting losses. On top of that, of course, those lenders wouldn’t be in business in the first place if they didn’t also leave room to make a profit.

Covering inflation, default risk, and leaving room for a profit margin is a lot to ask from 3.5 percent – especially when inflation alone has averaged 4.15 percent a year over the past 50 years, according to the BLS. Logically, this means those 3.5 percent mortgage rates may be an endangered species.

Here are three things you should take away from this:

If you’ve been thinking of buying a house and can afford to get into the market now, don’t delay. Mortgage rates certainly aren’t going to get much cheaper than they are now, but they could get more expensive.

If you could save money by refinancing now, you might miss your chance if you try holding out for a better opportunity. With rates still near their all-time low, this is probably the wrong time to be playing chicken with the market.

Be cautious about adjustable-rate mortgages (ARMs). ARM rates may be nearly a full percentage point cheaper than 30-year fixed mortgage rates, but that advantage may be short-lived if mortgage rates are beginning to return to more normal levels. An extraordinarily low mortgage rate does you little good if you can’t lock it in.

It’s too early to say whether the era of super-low mortgage rates is starting to end, but this is a good time to keep a wary eye on where those rates are headed.